Housing affordability: addressing a structural challenge without compromising returns

Chronic undersupply has plagued the United States’ multifamily rental market over the last decade, with supercharged construction costs challenging the bottom line of investors and developers alike. This has contributed to a growing misalignment between the type of supply delivered and affordability across the housing market. This trend, coupled with a high interest-rate environment, has only advanced rent burdens across income segments, especially within the low to middle-income brackets. Today’s investors are well positioned to take advantage of residential market conditions to diversify their residential portfolios. Investments in traditional and alternative residential subsectors, elevated by a hyper-local investment thesis with a focus on essential rental housing, could generate strong financial returns while addressing the challenges facing the ever-growing number of renters in the United States. 

Defining affordable and attainable housing

Stakeholders use a variety of terminology— attainable, affordable, workforce housing—when referring to the investable landscape of essential multifamily housing. For purposes of this article, we consider two broadly accepted metrics as measures of affordability: housing costs and associated utilities as a percentage of household income and rental costs as a percentage of area median income (AMI). 1 We distinguish between subsidized housing—often referred to as Big A Affordable—and nonsubsidized housing—referred to as little a affordable, attainable, or naturally occurring affordable housing (NOAH). We consider workforce housing to be a subset of attainable housing targeted at the missing middle of renters, such as teachers, police officers, nurses, and firefighters whose incomes don’t qualify for subsidized housing but who often can’t afford to live within reasonable proximity of their jobs.  

Many institutional investors have increased their allocation to, and focus on, affordable and attainable housing, attracted to favorable fundamentals and driven by accountability to investors and capital sources with social responsibility objectives. 2 According to the most recent PREA Consensus survey, 79% of global respondents consider the ability of a fund to promote environmentally and socially responsible investments 2. U.S. affordable housing investment volume grew to $13.5 billion in 2021, from just $674 million in 2009. Although volumes have declined from peaks, quarterly averages were about 50% above pre-COVID levels when last measured in H1 2023, consistent with other commercial real estate (CRE) sectors. 

Market drivers for affordable and attainable housing

Perhaps the most prevalent market driver for affordable/attainable housing investment today is the growing affordability gap permeating much of the United States. Both would-be buyers and renters are facing record-high housing costs, fueled by high interest rates and an inflationary environment. Costs continue to rise in both the for-sale and rental markets—home sales prices nationally average about five times the median household income and rents are up 26% nationwide since early 2020. Further, the United States faces long-term structural undersupply, even as select markets are experiencing multifamily rental supply shock—renter household growth outpaced the number of homeowner households by three times in Q2 2024.

Structural undersupply, specifically a lack of housing units that are affordable for today’s renting population, is the biggest driver for this segment of the housing market. Generally, housing production in many major markets hasn’t kept up with household growth since the global financial crisis, hampered by restrictive zoning and cumbersome entitlement processes. Multifamily completions were at a 15-year low between 2010 and 2015 as the economy recovered. 3 More recently, pandemic-triggered net migration into lower cost-of-living markets disrupted the supply pipeline further. A substantial portion of net migration reflected corporate relocations into these markets, leading to an influx of higher-income jobs, and triggering a rapid increase in the price of both for-sale and rental housing in these markets. As mortgage and financing rates crept up, developers sought to leverage record-high rental growth through higher-end multifamily and built-to-rent development. What resulted were more acute housing challenges for essential workers and other median- or lower-income individuals who were pushed out of these previously affordable areas. Amid demographic shifts and the lingering pandemic impact on the population and the broader economy, the United States faces a pressing need to build 4.3 million new apartments by 2035, of which the states of Texas, Florida, and California account for 40% of future demand, requiring 1.5 million apartments.  

Although record levels of new multifamily supply continue to deliver, there remains a misalignment between the price point of newly delivered rentals and what households can afford. We anticipate that the rate of deliveries will continue decelerating further over the next 12 to 18 months as developers have been sidelined due to the high cost of debt and limited capital for development risk. This environment, compounded by high construction and labor costs, among other constraints, will further amplify undersupply and the need for more affordable housing options. 

The case for investment

Investors have long held conviction in residential investment because of strong and broad demand-side fundamentals that underpin the sector. In particular, multifamily housing is a necessity-based asset that generates competitive returns. Compared with other traditional CRE sectors, multifamily residential may also offer a countercyclical and inflation hedge with the ability to reset rents more quickly, generating consistent income growth. Recession-resilient economics highlighted by high occupancy, lower concessions, persistent rent growth, low turnover, and the use of government vouchers as a backstop that reduces credit loss all translate to stable risk-adjusted returns. We note that affordable/attainable product is increasingly complementing other multifamily exposure in institutional portfolios. Long-term supply shortage advances the potential for both strong risk-adjusted returns and the increase of provision in housing to the missing middle, which addresses many limited partners’ objectives for positive social outcomes. In today’s capital markets environment, however, investment opportunities are challenged by the lack of market product as well as difficulty in underwriting rent growth to support the investment basis, while institutional-quality market-rate product demand is contracting.  

Manulife’s investment strategy stems from a research-driven approach to identify themes and sectors with long-term viability for outperformance. The durability of affordable/attainable housing is attractive, particularly in today’s market environment, as it delivers competitive returns with the opportunity for higher yields, given the right approach. The ability to structure complex solutions for today’s developers and operators using data for hyper-local supply and demand analytics will give a competitive edge and position portfolios to outperform. In this environment, market leadership in sourcing, analyzing, and structuring opportunities that address solutions across the capital stack for affordable and attainable strategies will benefit portfolios with higher-yielding investments while improving social outcomes. 

As an example, Manulife IM is actively structuring opportunities across this sector that bring a private equity approach to maximizing the dislocation in the current market environment. We see a strong window for GP-interest transactions in affordable housing that realize a higher revenue stream than would be available to a tax credit-oriented investment strategy. Further, a hyper-local focus on market trends and insight supports bespoke strategies where supply may be miscalculated and demand is misunderstood, helping us to identify opportunities that may offer outsize performance potential.

Affordable and attainable strategies are more complex and require a differentiated asset management playbook: The next cycle of investing offers a moment in time in which managers can drive outperformance. As we look at near-term opportunities, we have conviction that prudent and nimble managers can achieve highly competitive returns and capitalize on the current capital markets environment while addressing structural misalignment in housing supply for the missing middle. 

1 When households spend more than 30% of their income on housing, they are rent burdened; when they spend more than 50% of their income on housing, they are severely rent burdened. We consider affordability in relation to AMI. Households earning between 80% and 120%, 50% and 80%, 30% and 50%, and 15% and 30% of AMI are typically defined as moderate, low, very low, and extremely low income, respectively. Accordingly, relative affordability for a moderate income household means that a household earning up to 120% of AMI is spending no more than 30% of its income on rent and utilities.

2 “Pension Real Estate Association Consensus Forecast Survey,” PREA, July 2024.

3 MBA Census, June 2024.